Clear Eyed Capitalist

Archive for July, 2006

I’m doing research this summer for an advocate for local economies. There’s also a national organization on this issue: BALLE – the Business Alliance for Local Living Economies. It’s not isolationist but emphasizes a shift in priorities. The feeling is that decision makers make better decisions when they’re part of the local economy. There are also lower transaction and transportation costs to consider. Some of the principles that guide a living economy (from the BALLE website ) – that investors seek “living returns” rather than maximum returns and that businesses value all stakeholders and balance their self-interest with their obligation to the community.

In the book “Freakonomics”, authors Levitt and Dubner explain that there are different kinds of incentives: economic, social and moral. One of their stories is about a daycare center study in which economists experiment with curbing late pickups by introducing a small fee. What they discover is that by switching from a social incentive for on-time pickup (minimized guilt) to an economic (financial) incentive, they’ve made late pickup very cheap and it increases considerably. Further, it seems to be difficult to switch back: once the fee is dropped late pickups increase yet again. They don’t pursue the story beyond the 20 weeks but the authors speculate that the dollar value that might be required to minimize late pickups could be so high as to engender resentment from the parents. It seems that in this case, the social incentive was much more useful and powerful. In a complete system of incentives, financial incentives are not always the best way to distribute a good, social incentives are important too.

Thus the importance of local economy – social exchanges remain part of the transaction and can act as a governing influence against exploitation. This is the problem with globalization – that more and more frequently we find ourselves doing purely financial transactions that are unencumbered by social or moral exchange. More and more people in our society are recognizing this as a problem, but few yet have been able to articulate very specifically what that problem is. We don’t have the same measuring tools for social and moral exchange that we do for financial. The Socially Responsible Investing movement has yet to identify a social performance metric, though progress is being made.

All of this is very much on my mind and crystallizes when I read that the Seattle Supersonics NBA team has been sold. For your crystals to form you’ll first need a bit of latticework – background on the Sonics over these past few years. The Sonics were bought a few years ago by a local investor group: Basketball Club LLC. This investor group is headed by two local business leaders: Howard Shultz, CEO of Starbucks (headquartered just south of downtown) and Wally Walker, longtime general manager of the Sonics under the prior local ownership. While the value of the team has increased considerably (some 30% at least given the asking price), this investment has proven to have a carry – meaning that on a cashflow basis the Sonics have been operating in the red and investors had to actually put in more cash. While that is not uncommon for investments and many investments, including this one, prove ultimately profitable with a carry, not all investors are comfortable with that model and apparently not these. Their goal was to cut costs so there would be no ongoing expense and their target fell on their lease agreement with the city for Key Arena where the team plays. They decided first they wanted to renegotiate the agreement to distribute more profits their way, and second that they needed a new arena altogether so they could make their desired profit.

Given that absolutely nothing had changed about their lease since they bought the team from the prior owner, it felt pretty clear to me and many fellow citizens that this was a bald move to cover their disappointing business decision out of the pockets of the taxpayer. Unfortunately for them, picking the pockets of the taxpayer is all about timing and theirs is terrible – it comes on the heels of a major failed transportation initiative and huge funding issues in replacing some major highways. Not to mention several very mediocre seasons of play which included the dramatic mid-season trade of some of the city’s favorite players.

They also have the disadvantage of being local. If Howard Shultz plays hardball with the city over the Sonics, what happens when Starbucks wants to expand their headquarters, or get help with traffic issues in their area of town? Payback, baby. If Wally Walker helps move the Sonics to another city that’s willing to “play ball”, how often will he have to hear about it from his landscaper, his fellow school parents, or would-be attendees for the next charity event he hosts a table at? Folks at the city Mayor’s office know this- I don’t think anyone took seriously their threats to move the team.

Solution? Sell the team to an out-of-town ownership group. It’s worth more to them because they can happily put the screws to the city. Oh, and coincidentally they’re from NBA-tested Oklahoma City where they can be heroes for bringing home a team (to replace the borrowed New Orleans Hornets which go back home in 2008.) Sure they’re committed to not moving the team – for as long as it takes to get Oklahoma City to work up a sufficiently competitive bid that they “have no choice” because of the relative value of the deal vs what Seattle is willing to pony up.

This is also a good parallel to how globalization has kept wages down. A credible threat of being able to relocate allows owners to retain a greater share of the pie when negotiating with employees. A credible threat of relocation will give basketball team owners a chance to negotiate for more of the costs to be carried by taxpayers. By being out-of-towners, they can negotiate very aggressively because their relationship with Seattle is purely a financial one. We have no social ties to bind them by and seemingly no recognized national moral code that’s allowed to impact business deals.

This is what makes a local economy a living economy – that social incentives remain part of transactions. We haven’t yet figured out how to measure what they add, but we’ve reached the stage where we can see that economic transactions without social ties are often very lopsided. It certainly emphasizes the opportunities for the rich to get richer if its easier for them to walk away from a deal or a relationship. That’s not to say that social ties are everything – tribalism and discrimination were good things to move away from, but we haven’t found the right direction yet.

I’ve recently joined the board of Washington CASH – Community Alliance for Self Help. They do a Grameen Bank micro lending model here in Washington State. This means that while loans are made to individuals, they must be signed off on by a peer lending group who is responsible for helping to pay it off. A distinguishing characteristic of these loans is that they are collateral-free. Thus they’re loans that regular banks can’t do. “Regular” Banks, particularly those that have FDIC deposit insurance, have rules about how risky they can get with their investing. Thus there’s a market need for institutions able to take bigger risks in categories that aren’t likely to interest private investors.

It’s actually tricky to do for two reasons: 1) our business economy is much more formalized – you can’t just go out on a corner outside the Mariners game and hawk your home-made snack. We have complex permitting, licensing and taxing that developing countries don’t have (or don’t enforce well). 2) lending groups in developing countries are often villagers who have many relationships. Here lending groups are formed by strangers brought together for 8 week classes. Obstacles aside, WA CASH is now in it’s 10th year of operation and has helped many businesses get off the ground, some of which have grown to have multiple employees. I’m looking forward to learning this area better.

As part of serving this category of need WA CASH is an official Community Development Financial Institution (CDFI), a class of institution that had attracted my attention because of the community focus. Shorebank Enterprise Pacific is a CDFI. To get clarity, I did a little bit of research into exactly what this means.

The Community Development Financial Institution is a designation created by Congress in 1994. Organizations apply to the Department of the Treasury for the designation, which must be renewed every 3 years. It can be renewed indefinitely. The CDFI designation makes an organization eligible to apply for federal funds via the CDFI program. Further the designation means that banks can count grants and loans to your org towards their Community Reinvestment Act requirements. By partnering with a bank the bank can apply for a Bank Enterprise Award (BEA).

To be a CDFI your org has to meet the following requirements:
 Be a legal entity at the time of certification application
 Have a primary mission of promoting community development
 Be a financing entity

 Either regulated, such as a bank, credit union, thrift
 Or unregulated, but demonstrate that your activities are primarily financial based on your staff time and your capital uses.
 Examples: Bank or Thrift, Credit Union, Depository Institution Holding Co (this seems to mean being the holding company of a bank, all affiliates must meet the requirements), A loan fund, A community development venture capital fund

 Primarily serve one or more target markets

 the target market has a geographic designation
 the target market is a LITP – Low Income Targeted Population which means 80% of Area Median Income or less (area either being the state or the local urban area)
 the target market is an OTP: Other Targeted Population; “Identifiable groups of individuals in the applicant’s service area for which there exists a strong basis in evidence that they lack access to loans, Equity Investments and/or Financial Services.” These categories seem to primarily be racial.

 Provide development services in conjunction with its financing activities

 Development Services are technical assistance or training activities that prepare borrowers to access the organization’s Financial Products. Examples include credit and/or homebuyer counseling, business plan development, or business finances training.

 Maintain accountability to its defined target market

 A CDFI Certification Applicant must demonstrate that it is accountable to its designated Target Market(s). A CDFI can demonstrate accountability through either its Governing Board, Advisory Board, conduct of focus group and/or community meetings or surveys within the Target Market.

 Be a non-government entity and not be under control of any government entity (Tribal governments excluded).

WA CASH focuses on a category of business called “microenterprise”. The Association for Enterprise Opportunity (AEO) says “AEO and the microenterprise development industry have defined a microenterprise as a business with five or less employees, which requires $35,000 or less in start up capital, and which does not have access to the traditional commercial banking sector.” According to another footnote on their website, this is in line with the SBA microloan program which makes loans up to a maximum of $35,000 (raised from $25,000 in 2000).

All on a very different scale than angel investing, where companies seem to be raising a minimum o f 3 million. All about capital structure and business model, though it’s hard to not also notice that one group is primarily white men while the other is primarily women of color. Long lines of history lead to here, how do we move towards a different future?